The stock market likes exceeding expectations. It does not like convertible bonds.
Most of us in and connected to the forex industry understand that we are all together in one big boat. Rising industry volumes generally mean good times for (most) everyone, while slow volumes hurt (nearly) everyone. There are always the haves and have-nots, firms managed better than others, but generally a rising tide should lift all ships in the sea of forex, and a falling tide vice versa.
So yesterday’s stock market activity in shares of some key publicly traded retail forex brokers begs some explaining. In a forex version of one of may favorite movies, Trading Places, we saw on the same day Plus500 (LON:PLUS) shares rise 17% while Gain Capital (NYSE:GCAP) shares fell 17%. Note that this was the second consecutive day of a 17% share price rise for Plus500.
What’s going on?
Thursday’s trading in NYSE:GCAP (blue) vs. LON:PLUS (green). Source: Yahoo! Finance.
Clearly the share price movements here are both company-specific, not industry-specific (industry leader FXCM, by contrast, eked out a modest 1.6% gain Thursday), and demonstrate two important principles to public companies generally, as well as to forex brokers looking at an IPO in the near future — and we know that there are a few.
First, Plus500. After putting out a brief trading update early Wednesday, in which it stated that it saw 2013 revenues “ahead of market expectations”, Plus500 has seen two consecutive days of 17% gains. Plus500 shares are now more than double their July IPO price (up 108%) , and the company is being valued by the stock market at about $465 million.
The Plus500 lesson? Plain and simple, the market likes when a company beats expectations. Doesn’t matter that Plus500’s most recent financial report showed slowing revenues during Q3 as compared to the first half of the year. Beat expectations, and the market will reward you.
Gain Capital’s 17% dive is a little harder to fathom. Wednesday evening Gain announced it was looking at (although hadn’t finalized) a $65-$75 million convertible bond offering. No big deal, right? Good news, Gain can now be more aggressive in pursuing acquisitions, right?
Wrong.
For companies with low trading volumes (Gain does about 250,000 shares traded per day on the NYSE), the stock market hates convertibles. Why? Very simply, as we explained yesterday Gain’s convertible bond offering is aimed only at institutional investors. And institutional investors are expected to largely hedge out the ‘convertible’ part of the bond, by shorting Gain shares – thereby creating synthetically a ‘straight’ Gain Capital bond, with a higher rate of interest than the convertible. Simply put, these investors buy convertibles and short the underlying stock, causing downward price pressure. And anticipating this coming shorting pressure, investors have very quickly dumped Gain shares now.
Recent studies have shown that companies such as Gain Capital announcing convertibles typically see a next-day share price drop in the 5% to 9% range. (See such studies here and here).
We are sure that Gain Capital’s investment bankers put somewhere in their presentation this convertible bond announcement effect, but we doubt that they expected it to be so much.
In the long run, Gain Capital’s shares will reflect the true value of the company, regardless of how it is financing itself. Do well and Gain’s share price will rise. Do poorly, and, well, you know what happens. But choosing the right corporate finance tools can indeed have a lot of near-term impact on a company’s valuation, as demonstrated today by Gain Capital losing 17% of its value.
Note that with the latest drop in its share price, Gain Capital is being valued at about $310 million, while Plus500 is now at $465 million — 50% more than Gain! Gain Capital does about $400-$500 billion of volume each month, while Plus500 is at just a fraction (about 1/7) of that. In its most recent quarter Plus500 reported about $20 million in revenues, and Gain Capital reported $61 million — more than 3x that of Plus500. Something isn’t adding up here in the valuations….
For more on the global Forex industry see the LeapRate-Dow Jones Forex Industry Report.